Many of these actions focus on reducing the initial costs of setting up the firm, disregarding the more important role of business registers as a source of reliable information for judges, government departments and, above all, other firms. This reliable information is essential for reducing transaction costs in future dealings with all sorts of economic agents, both public and private.

The priorities of reform policies should therefore be thoroughly reviewed, stressing the value of the legal institutions rather than trivializing them as is often the case in those reforms inspired by Doing Business.

An article by Luis-Felipe Mohando analyses Doing Business Enforcing Contracts index concluding that all of its three componentsthe number of procedures, cost and time of a lawsuit related to a sale of goodsare problematic: the first needs more solid theoretical foundations, the second is at odds with economic theory, and the third needs improvement to guide policy.

He argues that

For more than 30 years now, the economic analysis of procedural law has shown that the most efficient procedural rules (in the sense of reducing the costs for society as a whole) are the ones that establish a court system that elicits the optimal number of lawsuits, minimises the probability and cost of issuing a wrong judgment, and also minimises the administrative cost of resolving the disputesby promoting out-of-court settlements. Such a system requires a procedure completely different from, and practically the antithesis to, the Reports ideal; that is, the costlier and the more legally sophisticated, the better.

Understandably, the consequences are not good for policy:

The Reports have the aim of motivating reforms through country benchmarking, informing the design of reforms, enriching international initiatives on development effectiveness, and informing theory. The Enforcing Contracts chapter has certainly missed the target.

In a post at the PSD blog, David Kaplan sees little difference between the “Doing Business” position and my own. He writes:

Part of Professor Arruñadas argument is that the Doing Business indicators do not capture all the relevant components of the business environment. The writers of the Doing Business 2009 report agree. . . . I believe that the debate is not mainly about what Doing Business measures. Really, the debate is about how these measures are used in shaping public policy. Critics of Doing Business are concerned that countries will ignore the above warnings and only reform in areas that are measured in Doing Business.

I doubt that one can separate what DB measures and how it does it from how DB measures are used in the field. My main complaint, however, is different, namely that the DB method has often lead to bad policy.

In the Starting a Business area, DB focuses narrowly on some costs (those paid by entrepreneurs at the formalization stage), while forgetting all other costs (e.g., costs paid by governments to build often-useless one-stop windows). More important, given that the method ignores the benefits of formalization, the DB method disregards the need to make business registers reliable. Thus, they often end up accelerating the production of useless paperwork. See for details on specific policies my 2009 paper on How Doing Business Jeopardizes Institutional Reform (European Business Organization Law Review, 10[4], 555-574.).

DB application and marketing have also caused trouble. For example, rankings are misleading when the method is applied differently in different countries. For example, the USA ranking, if correctly applied, would have brought the USA down in the DB Starting a Business index from positions 3-5, to positions 57-60 in DB 2008, and later to positions 94-98 in DB 2009.

Of course, measuring institutions is hard. Emphasis should lie in improving measurement methods. Unfortunately, DB has shown little willingness to learn from past mistakes and improve its methods. On the contrary, it has prematurely bet on having a policy impact, exploiting the proclivity of the media to cover rankings and the use that the MCC made of DB data to allocate aid money. However, as readers of this blog perfectly know, strong incentives work only when there are good measures of performance.

This has intensified another negative impact of DB: its simplistic policy advice and the exaggerated marketing of its rankings have discredited free-market policies. Free markets need reliable public institutions. By focusing on some of its costs without paying due attention to its functionality, DB has favored policies with misguided priorities, especially damaging in countries where such institutions are not working. For example, speeding up company registration should not be the priority when registration certificates are not valued by courts.
Comments at the Organizations and Markets blog.

Following continuing pressure by U.S. legislator Barney Frank, chairman of the House Financial Services Committee, The World Bank decided in April 2009 to drop Doing Businesss Employing Workers Indicator and develop a new Worker Protection Indicator after concluding that the first indicator does not represent World Bank policy and should not be used as a basis for policy advice or in any country programme documents that outline or evaluate the development strategy or assistance programme for a recipient country (Aslam, 2009).

In line with my argument, meaningful indicators of institutional quality should be comprehensive of costs and values. Therefore, an indicator of the quality of employment regulation should consider not only workers protection but other aspects, such as, most prominently, unemployment rates.

The German Development Institute has held an interesting workshop on “The Doing Business agenda and beyond: Smart policies for competitiveness and social inclusion” (Bonn, December 4-5, 2008). Presentations are available here.

In Seven Theses on Doing Business, Christian von Drachenfels, Tilman Altenburg and Matthias Krause, of the German Development Institute, analyze several merits and failures of DB to conclude it should clearly state that they only measure the private costs of regulation. Neither the benefits of regulation for enterprises and society at large, nor the administrative capacity of governments (i.e. whether they employ regulations as a means to maximize welfare or to extract rents) get measured. The rankings would probably look quite different if these elements were taken into account. The point that minimal regulations is in most cases not a reasonable policy target, should be pointed out clearly.

In Be Careful when Doing Business, Bjorn Hoyland, Kalle Moene, and Fredrik Willumsen criticize Doing Business rankings because they hide the weak discriminating powers of the indicators. They recommend greater transparency in their making.

In Ease of Doing Business at World Bank, (The Economic Times, 26 June 2008) Columbia University Professor Arvind Panagariya calls attention to the contrast between the poor scores reached by India and China in the DB rankings and investors behavior and argues that as long as media continues to love these indexes, those seeking limelight on the cheap will continue to produce them. He concludes that, given its flaws and minimal role EDB index plays in informing policy makers, the natural course of action for the World Bank would be to economise on its scarce (and publicly funded) resources and close down the business of Doing Business.

However, the IEG did not find evidence that the DB indicators have distorted policy priorities (p. xvii) and asserts that “there is little evidence that the DB indicators have distorted policy priorities in the countries or in the Bank Groups programs” (p. 53).

My Working Paper on How Doing Business Jeopardizes Institutional Reform argues that DB does distort Starting Business policies. The main sections of the paper explain why Doing Business methodology is jeopardizing Doing Business own objectives in this area. It also outlines three sets of changes that need to be introduced in Doing Business aims, governance and methodology.

I have been told by the editors of the Journal of Comparative Economics that Simeon Djankov has decided to withdraw his forthcoming response to my 2007 article. The editors have decided not to publish my reply either.

Both Djankovs response and my reply had been accepted for publication at the next issue of the journal. In fact, the corrected proof version of Djankovs response has been published at the journals site at Science Direct since February 5 2008.

In essence, the success of the Doing Business project (DB) has made administrative simplification popular. Unfortunately, by its systematic flaws, DB methodology exerts a perverse influence on the design of such policies. Djankovs response to my analysis shows again what I criticized DB for: its narrow focus on some costs and rent seeking damages reform efforts.

Moreover, the macroeconomic benefits of reducing the cost of initial formalization, which is just a tiny component of total entry costs, should not be exaggerated. Entrepreneurs remain informal mainly because formalizing their businesses increases their tax burden withoutin many developing countriesreducing their transaction costs. Empirical tests using DB indexes are of little help in this discussion as they have severe limitations.

Doing Business has been successful in putting the reform of the business environment on the policy agenda. There may still be time to redirect this success in a productive manner. This would, however, require substantial restructuring of DBs aims, governance and methodology. Otherwise, its marketing success will keep damaging business.

Simeon Djankov, the creator of the Doing Business series, has written a “Response” to my critique. He argues that

Simplifying entry regulation has been a popular reform since the publication of de Soto (1989) and Djankov et al (2002). The inclusion of business entry indicators in the World Banks Doing Business project has led to a further acceleration in reform. A contrarian view posits that such reforms reduce legal certainty without bringing positive economic or social benefits. This note suggests that this worry is unfounded. The resistance to reforms has come from the beneficiaries of complex entry regulation: notaries, corrupt judges, court clerks and other government officials. In every reform country, these have fought hard to maintain their rents, which come at the expense of new jobs, new businesses, more investment, less corruption and a smaller informal sector.

Wade Channell, from USAID, proposes in Uses and Abuses of Doing Business Indicators, that it isnt the indicators but the way they are used that presents problems. Channell says that Doing Business numbers reflect symptoms but dont diagnose the disease or recommend a cure and thus are open to interpretation which in some cases can be ill-considered.

Wade refers above to the possibility that introducing a notice or recording system in a country with heavy ex ante controls may cause uncertainty.

Let me add that a system of mere notice depends more heavily on ex post legal and judicial services. It is understandable that parties fear that when ex ante procedures or controls (whatever their effectiveness) are voluntary, judges (at least some judges) may think twice about the value of any document which lacks one of these controls. This (in addition to neglected value) helps explaining that even after liberalization some of these controls are still used. It is also understandable that other parties prefer to maintain these procedures in order to reduce their liability. This includes both private and public parties: e.g., banks in some countries say that notaries add no value in mortgages but protect them against opportunistic borrowers playing the weak party. Also, registers in New Zealand were told to prefer solicitors directly registering in order to reduce the registrars own work and liability.

On a minor point, equating notice systems and common law is too simple. At least in property, the borders do not respect these old and maybe outdated categories: e.g., France, Italy and the US have deed recording, Germany and Spain but also Australia and the UK (what a transplant!) have registration. (I myself did some econometrics along these lines in Property Enforcement as Organized Consent, J. Law Econ & Org, 2003; available here as WP).

This perhaps throws a new light on the main issue that Wade poses: How to transplant legal institutions efficiently. Two starting points, as applied to registers, are in my opinion: (1) To measure them correctly, considering costs as well as benefits, both ex ante and ex post. (2) To prioritize value, understanding thatwhatever the designregisters need to be fully reliable in those services with legal effects (i.e., at least in correctly dating and safely keeping documents under the notice systems).

Despite the evident and mythical convergence between civil and common law traditions (among others), the similarities between the two may in fact be false cognates in some instances. In my work on legal reform elsewhere, one of the complaints I have heard frequently is that expatriate specialists often fail to fit their recommended amendments properly within the local system. Much of this is due to a failed approach to policy development and legal drafting (which excludes local stakeholders), but increasingly I see that it’s more.

There is sometimes a failure to see that new mechanisms – even if drafted solely by local stakeholders – may not fit within the existing systems. Aside from your insightful comments about bribery and misuse of “improved” systems, such as a one-stop shop, you have raised the very important question of confidence and legitimacy. A new approach means that banks may not in fact feel confident, and may be reluctant to work within the changes. If the notice system undermines certainty, then the efficiencies gained may be illusory.

But then, this is a dynamic question related to shifting paradigms and changed expectations. Banks are by nature averse to uncertainty. Vested interests (notaries not the least) are averse to changed influence and income flow. A change from the continental rights registration system to the more common law notice system means that numerous actors must adjust their own approaches and expectations, and that will take time. Time is frequently not a part of the donor world gameplan.

It’s interesting to compare some of these changes with the advent of the internet (which has driven many of the recommendations for simplified approaches). The internet was invented and developed in a common law jurisdiction, protected by common law legal concepts, but no one has rejected it as “inconsistent with our legal culture”. It overcame vested interests and legal concerns because people immediately saw its benefits and demanded that the system be made available. The quality and quantity of champions for reform created a revolution in technology and habits in a few short years.

The benefits of recommended changes in business and property registration may not have the same level of demand because (1) they are not well understood, (2) they are less immediate, more complex, and costly to obtain, (3) vested interests clearly understand the negative impact and thus mount campaigns against the changes (normally based on culture, history, uniqueness, legal legacy, or “the good of the nation”), and (4) the benefits may in fact not be so clear. It is this fourth point you are raising and I think it deserves greater attention.

I work extensively on movable property systems, and I promote notice registries, which are new to almost all systems. (They’ve only been around for 50 years or so.) What I’ve found is that when the banks understand the benefits (in a competitive banking environment), they become the champions and the reforms take off rapidly. When the banks do not see any benefits (usually in a moribund, non-competitive banking environment) or are not permitted to define the parameters of the system, very little happens.

So the question of benefits is quite at the center of analysis. The real question is “benefits for whom?”

Max is right about the need to focus on regulation instead of one-stop shops. Besides, by disregarding the existence of private one-stops (the so-called facilitators), Doing Business is precluding any reform that might rely on these private agents, and promotes instead those reforms which create new, often public, and often more bureaucratic one-stop shops. In other words, I find awkward that most reforms try to create them anew instead of redesigning the systems to allow preexisting private facilitators to act as market-driven one-stop shops. (For example, the lawyer that undertakes all the necessary steps for the big firm).

Perhaps time to explore an alternative reform strategy, redesigning the interfaces of public agencies so that the variety of existing private facilitators could evolve and serve as effective one-stop shops?

I also agree with Max and others: The indicators are been misused and have bad effects. Perhaps also time to collect information systematically on such misuse?

Interesting stuff. Benito makes a good point, especially if countries only react to the indicators as a way of looking better in international eyes. Also the notion of setting up “one-stop shops” to ease an investor’s way through a regulatory nightmare is all very well, but the real policy should be to reduce the scope of regulatory reach, as in many UDCs complex regulation simply provides an opportunity for corruption.

I applaud the recognition that these indicators are subject to misuse. The current rush to improve time and cost of starting a business in order to receive MCC or other funding does not necessitate any improvement in the underlying business environment. As Benito points out in footnote 9, I recently was castigated by Afghan businesspeople who asked that USAID stop bragging about Afghanistans stellar performance in the Starting a Business indicator because all of the bureaucratic barriers had been moved to the next phase  licensing. It still took more than a year to open a business, but most of the delay is now after the initial registration.

The problem of misuse needs to be addressed. The indicators are what they are  a simple snapshot of proxies that suggest certain efficiencies or inefficiencies in the business environment. They are like a quick examination of a patient that shows blood pressure, temperature, pulse, dilation, etc to determine the basic conditions of health. A fever tells you something is awry, but it does not diagnose the cause. Those of us on the implementation side of reforms are perhaps best positioned to advise that changing indicators is not the same thing as changing health, any more than giving a malarial child an ice bath to reduce a fever will cure malaria.

The possible uselessness of many ex ante controls does not refute my point about the need to emphasize the value of the institution. Even in a regime of notice (or recording) the filing office must be reliable with respect to those dimensions of the filing which produce legal effects: at least, the dating of the notice, the keeping of records and the issuing of certified copies.

The existence of such legal effects has an important consequence: speeding up the filing (as is often done) is irrelevant if the filing office is still willing to antedate a filing, lose a filed document or to issue a false certificate for a bribe. Considering the value of the institution should be the first priority of any reform in this area. In general terms: whatever the extent of their legal effects, registers must be reliable with respect to such effects.

In theory, a notice system (similar to what in land titling is often called recording, as opposed to registration) should cause lower costs ex ante because it requires less of both private services (such as notaries and lawyers) and public services (registries). It should however cause greater costs ex post: in both private services (lawyers, due diligence) to examine the filed documents before contracting and possibly to litigate more, and in public services (judiciary) to decide such greater litigation. This is our argument in the The choice of titling system paper published at the J. of Law & Econ in 2005 (WP version).

In reality, however, this tradeoff may not hold. For instance, the data compiled by the European Mortgage Federation for land transactions, data which I use in a recent paper on the regulation of conveyancers (Eur. J. of Law & Econ 2007, WP version) tells us that registration not only, as expected, reduces ex post costs (faster and cheaper foreclosures) but achieve this incurring lower costs ex ante, both private (notaries, solicitors) and public (registration fees) costs. I suspect that the reason lies in the fact that registration uses similar patterns to those that characterize modern industrial production: it avoids defects from the outset, making it possible to produce safe, standard rights. Recording, on the other hand, does not correct defects, transactions of diverse legal quality are all recorded, and defects and evidence pile up in chains of title deeds which become more complex with each transaction and have to be thoroughly investigated.

In addition, we cannot assume that the costs of verifying a notice register are always low. Such verification cost: (1) hinges on how well the register is organized, and (2) it is inf fact infinite if the register is unreliable or corrupted.

Benito highlights two different approaches to business registration. One I will call continental for lack of knowing the correct term. In the continental approach, the process of registration has traditionally involved a judge, notary, or other specialist who ensures that certain structures, approvals and documents are in place in accordance with law, whether that law is simple or complex. In essence, they give a stamp of approval for the registered company.

In the notice registry system (again for lack of a correct term), registration is a mere administrative procedure that does not need a great deal of involvement from specialists. It indicates that the company has filed certain required papers, but nothing more. It is extremely simple (Delaware lawyers have boasted to me that a company can be created in 45 minutes).

The difference is more than one of simplicity and fewer regulations. The notice system is built on a presumption of caveat emptor  buyer beware  so that anyone doing business with the corporation investigates much more than whether the company is incorporated. There is no presumption that a company, for having registered, is anything more than a shell. Due diligence by banks are potential partners may therefore be rather intensive.

The continental system arose from an ethos of approval  incorporation was a mark of imprimatur that gave certain assurances of the creditworthiness and reliability of the system. Unlike the notice system, not just any fool could open a company, at least in theory. Consequently, there is a certain amount of due diligence built into the registration process, so that banks and potential business partners in the continental system can rely more heavily on the act of registration than can their counterparts in the notice system.

The Doing Business indicators are clearly biased toward the notice system. There is an assumption, in great part built on the breakdown of protections that used to be built into the continental system, that many of the steps, procedures and approvals that are currently required, especially in developing countries, are costs with no benefits. They hint of government controls over economic activity, whereas Doing Business clearly leans toward government facilitation of economic behavior. Simplicity and low cost are generally therefore more facilitative.

Benito appears to be arguing, without stating the specifics, that many of the registration requirements that those racing to improve their Doing Business ranking are dismantling are in fact valuable protections that reduce transaction costs in the long run, although not at the start up phase. While not sure that this is true, it certainly reminds me of an analogous situation I found in Bosnia when I was arguing for legal changes that would reduce certain regulations that I felt were burdensome and misplaced. One of my Bosnian colleagues pointed out that I was assuming a system of consumer protection in which citizens felt both the right and ability to complain of consumer problems and did not need government protection, whereas Bosnia had never known such a culture and still needed some form of government protections on behalf of consumers. In other words, the shift to self-protection was premature and the regulations should be left in place.

I would like to see a more specific and thorough listing of the protections that Benito perceives as being jettisoned. It is my bias that most of the government regulations in this particular indicator area create costs without benefits, yet he clearly disagrees. This suggests that Im missing something.

It could well be that Benito is also recognizing a gap similar to the Bosnian consumer issue: the continental system is shifting, but the institutions have not yet adjusted to the shift, thus creating new uncertainties with no established approach to addressing them.